Rabobank sees 1.26-1.27/$ as strong level for euro

Fears of euro exit by Greece continue to swirl with talks now surrounding when the debt saddled nation will walk out of the common currency bloc.

Jane Foley, senior currency strategist, global financial markets, Rabobank International says that the probability of a 16 membership European Union has certainly risen over the last few weeks.
Markets are turning to the European Central Bank to bring in some clarity, even as the situation between the euro-dollar continues to remain tense. Foely sees 1.26-1.27 as a strong level for the euro psychologically. Below is an edited transcript of her interview to CNBC-TV18. Watch the accompanying video for more. Q: In the past 24 hours we have heard quite a bit of events - some Greek banks not getting money and told to recapitalise themselves, Mr Draghi making some statements about key assumptions of the euro zone which cannot be sacrificed. What's the market penciling in by way of a Greek exit?
A: Right now opinion polls are saying that most Greek people do want to remain within the system. However, if you go back to the May 6 general election, around 70% of the electoral voted for policies that were anti-austerity. What we can infer from that is that the people want to remain in the system but they don’t necessarily want to play by the rules, the rules being of course structural reform and austerity.
Now most analysts would suggest that that’s just not possible if they want to remain in the system they will have to play by those rules. What we will have to wait and see is whether or not the election in June will bring a greater understanding of the link between the two. For now, it seems that if the election brings similar results that they did in May well Greek could easily find itself heading out of the system meaning that the probability of a 16 membership European Union has certainly risen over the last few weeks. Q: We have seen a goodish bit of rise in Spanish and Italian bond yields, that’s the collateral damage because of the events in Greece. Last time when the yields went above 6% we did get an LTRO (Long-term refinancing operation) from the ECB. Should we expect that the ECB will move and we could expect some kind of bond purchase noises?
A: Yes, the more we see Spanish bond yields rising, the greater the chance the ECB will have to step in. Of course, the ECB in its previous policies can only really be fire fighting, it’s not providing a cure for the crisis, it’s providing politicians with time. We all know that now but the ECB is the only institution that can act swiftly.
When it comes to structural reform then may be that is what it will eventually make the euro zone into a long-term coherent system. But structural reform can take a long time to yield results. Therefore, as these pressures grow it will be the ECB that the markets will be waiting for to come in and soothe market worries. Q: Yesterday we saw the euro pullback from levels which were sub-1.27 to go all the way up to 1.274and even yesterday the Fed in the FOMC minutes have kept the window open for a QE3, ECB as well may do so. What does all this mean for the euro - perhaps the range for the month or quarter?
A: The market has been eyeing the January low which is around about 1.2620 level. That sort of region will certainly be a very strong psychological level now. If that goes then there is every risk that we can go back to 1.25. I would say between now and June, up until the Greek elections and potentially beyond, there will be a lot of concerns that the euro will fall and that it could fall even maybe beyond that.
But there will be days when there will be more positive headlines and there will be relief rallies. For now, we could have quite easily imagined taking this back above that 1.28 level and potentially even to 1.30. I would expect that over the next month or so, we will certainly have the potential for more volatile conditions in euro-dollar than we have been seeing for most of the last two years because apart from the obvious months of heightened tension, lots of the period in the last two years has seen the euro-dollar trading in a pretty dull range. Q: Many of the emerging market currencies like the rand, ringgit, the rupee etc all of them have fallen very sharply. Do you see more such falls especially for the rupee?
A: I certainly think many of these emerging market currencies will see further falls in this sort of environment. It remains a fact that many emerging market currencies have relatively high correlation with other risky assets say the S&P for instance or even the VIX. As traders tend to move back into safe haven assets, such as the dollar when the crisis gets bad and over the last week or so, it has been the dollar that has been performing well despite the dollar’s arguably weak fundamental backdrop.
Clearly, the rupee has been under pressure as well as the links with risk appetite. Many economists are concerned about the outlook for some of India’s more fundamental positions, there is the current account balance etc. So that is certainly one which will be vulnerable over these next few weeks. Q: Would you say there could be foreign investors or smart money outflows from emerging market equities and currencies or do you see some of them attractive enough to attract inflows?
A: I think that could certainly happen. It very much lies on the outlook or the political position with respect to Greece, with respect to Spain etc. This isn’t just about Greece per se but it really is about the threat of contagion into Spain, into Italy and beyond. If politicians manage to ring fence some of those fears about contagion then the dollar will not see excessively high levels. However there is every risk that contagion does persist and of course we are seeing very strong signs of that and under this environment, the dollar will remain the most favourite currency suggesting as I said euro-dollar could certainly go beyond that 1.2620 level towards 1.25 level and the dollar index too will also be heading higher.